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Time Runs Out for Retroactive Rules on Tax Reform

The 2017 Tax Cuts and Jobs Act took effect on January 1, 2018. Section 7805 of the tax code generally permits the IRS and Treasury to issue regulations that are retroactive to the effective date of a statutory amendment only if the regulations are issued within 18 months of the effective date. This means that Treasury and IRS had until June 22 to issue final regulations that could have applied retroactively to the date that tax reform took effect. 

In January, we inventoried the outstanding guidance on 15 key tax reform measures here. As can be seen from the update below, although June 22 has come and gone, few final regulations have been issued in respect of these measures.

    1. Corporate Tax Rate

Reduces the maximum corporate tax rate to 21% from 35% effective 2018 and repeals the corporate alternative minimum tax. 

  • Notice 2018-38.

    2. Partnership and S Corporation Taxation

An individual taxpayer or trust generally may deduct 20% of domestic qualified business income from a partnership, S corporation or sole proprietorship, capped at the greater of (i) 50% of the taxpayer’s allocable or pro rata share of W-2 wages paid by the partnership, S corporation or sole proprietorship, or (ii) the sum of 25% of W-2 wages paid plus a capital component equal to 2.5% of the unadjusted tax basis of the business’s tangible depreciable property.

The full deduction generally does not apply to specified service businesses, except in the case of a taxpayer whose taxable income does not exceed $315,000 for married individuals filing jointly or $157,500 for single individuals (with the benefit of the deduction phased out between $315,000 and $415,000 for married individuals and $157,500 and $207,500 for single individuals). 

  • Notice 2018-64; Notice 2019-07; Proposed Regulations (REG-107892-18, REG-134652-18); Revenue Procedure 2019-11.

     3. Carried Interest

The required holding period for long-term capital gains is increased to three years in respect of certain partnership interests transferred in connection with the performance of services by taxpayers.

  • Notice 2018-18.

    4. 30% Limitation on Interest Deductions

Deductions for net interest expenses for all business entities would be limited to 30% of the business’s “adjusted taxable income” (as defined, similar to EBITDA). The computation of “adjusted taxable income” will become less taxpayer favorable in 2022 when “adjusted taxable income” will be reduced by depreciation, amortization and depletion. Any disallowed interest expense may be carried forward indefinitely. 

  • Notice 2018-28; Proposed Regulations (REG-106089-18); Revenue Procedure 2018-59.

    5. Dividends Received Deduction

Effective in 2018, a corporation may only deduct 65% (rather than 80% under current law) of dividends received from U.S. corporations in which the receiving corporation owns more than 20% of the stock, and a corporation may only deduct 50% (rather than 70% under current law) of dividends received from other U.S. corporations. 

    6. Shift to Quasi-Territorial International Tax System

Generally, the current worldwide tax system would be converted into a quasi-territorial system through the exemption of 100% of the foreign-source portion of dividends paid by a foreign corporation to a U.S. corporate shareholder that owns 10% or more of the foreign corporation.

Each 10% U.S. shareholder of a foreign subsidiary would be subject to a one-time tax on its share of the foreign subsidiary’s historical earnings and profits (“E&P”) not previously subject to U.S. tax (the 15.5% rate would apply to E&P attributable to cash and 8% rate to the remaining amount of E&P).

Foreign tax credits may be available to offset a portion of this tax, and a taxpayer may elect to pay the tax liability over eight annual installments (first five installments each equal to 8% of the liability and sixth, seventh and eighth installments equal to 15%, 20% and 25%, respectively.) Future distributions of E&P subject to the one-time tax would not be subject to a second tax upon receipt.

  • Notice 2019-01; Notice 2018-07; Notice 2018-13; Notice 2018-26; Notice 2018-78; Proposed Regulations (REG-114540-18, REG-104352-18, REG-104226–18, REG-105600-18); Treasury Regulations Finalizing REG-104226-18; Revenue Procedure 2018-17.

    7. Base Erosion Anti-Abuse Tax

A 5% minimum tax (increased to 10% in 2019 and to 12.5% in 2026) would be imposed on U.S. C corporations calculated on a modified tax base that excludes certain deductions, including deductions for payments made to a related foreign party. The minimum tax would only apply to corporations with average annual gross receipts of at least $500 million that derive at least 3% of their deductions from payments made to a related foreign party. Special rules apply to banks and securities dealers. 

  • Proposed Regulations (REG-104259-18).

    8. Reduced Effective Tax Rate for Foreign-Derived Intangible Income of U.S. Corporations

A U.S. corporation would be subject to a reduced 13.125% effective tax rate between 2018 and 2025 after permitted deductions (16.406% effective tax rate beginning in 2026), rather than the new 21% corporate tax rate, on foreign-derived intangible income (generally, intangible income of a U.S. corporation from foreign sales, including licenses and leases, and foreign services that exceeds an implied 10% rate of return on its tangible business assets). 

  • Proposed Regulations (REG-104464-18).

    9. Global Intangible Low-Taxed Income of Foreign Subsidiaries

A U.S. corporation would be subject to a 10.5% U.S. tax (increased to 13.125% beginning in 2026) on the global intangible low-taxed income (GILTI) earned by its foreign subsidiaries, which is the amount of income of a foreign subsidiary that exceeds an implied 10% rate of return on its tangible business assets. Only 80% of foreign taxes paid on GILTI would be allowed as a foreign credit. Proposed regulations would allow large multinational corporations to aggregate their entities for the purpose of calculating the one-time tax. Proposed regulations would also expand a high-tax exclusion under GILTI on an elective basis to include certain high-taxed income that would not otherwise qualify for the exclusion.  

  • Notice 2018-67; Proposed Regulations (REG-104390-18, 104464-18, REG-101828-19); Revenue Procedure 2018-48.

    10. U.S. Tax on Sale of Partnership Interests

A non-U.S. partner in a partnership would recognize gain or loss treated as “effectively connected” to a U.S. trade or business upon the sale of the partner’s partnership interest if the partner would be treated as having effectively connected income from a hypothetical sale of all the partnership assets. The transferee would be required to withhold 10% of the amount realized, unless the transferor certifies that it is not a foreign person. This provision would effectively codify the IRS’s current view and override Grecian Magnesite, a recent Tax Court decision.

  • Notice 2018-08; Notice 2018-29; Proposed Regulations (REG-113604-18).

    11. Capital Expensing

Generally, businesses would be able to immediately “write off” or expense 100% of the cost of qualified property, including certain real property, acquired and placed in service between September 28, 2017 and December 31, 2022, with a phase-down of full-expensing by 20% a year in the case of property placed in service after December 31, 2022 and before January 1, 2027 (i.e., allowing an 80% deduction for property placed in service in 2023, a 60% deduction for property placed in service in 2024, a 40% deduction for property placed in service in 2025, and a 20% deduction for property placed in service in 2026). 

  • Notice 2018-30; Proposed Regulations (REG-104397-18); Revenue Procedure 2019-08; Revenue Procedure 2018-25.

    12. Net Operating Losses

The use of net operating losses (“NOLs”) would be limited to 80% of taxable income for losses arising beginning in 2018. Taxpayers generally may carry forward NOLs indefinitely but may not carry back any NOLs. 

  • Notice 2018-30; Proposed Regulations (REG-106089-18).

    13. Like-kind Exchanges

Like-kind exchanges would generally be limited to only real property. Guidance is expected after the June 22 deadline.

    14. Deduction on Executive Compensation

U.S. and certain foreign public companies generally would not be able to deduct compensation paid to “covered employees” of over $1 million as a result of the repeal of the “performance-based compensation” exception.

  • Notice 2018-68.

    15. Insurance Companies

The Tax Reform Bill contains extensive changes to the taxation of insurance companies. 

  • Notice 2018-41; Proposed Regulations (REG-103163-18); Revenue Procedure 2019-10; Revenue Procedure 2019-06.

Key Contacts

Adam Blakemore
T. +44 (0) 20 7170 8697

Linda Z. Swartz
T. +1 212 504 6062

Jon Brose
T. +1 212 504 6376

Andrew Carlon
T. +1 212 504 6378

Mark P. Howe
T. +1 202 862 2236

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